SORRY: No Mention Of QE3 In Bernanke's Big Speech In Atlanta

Tonight Ben
Bernanke is giving a big speech at a conference at the
Federal Reserve Bank of Atlanta.

The speech kicks off a jam packed week of Fed heads speaking all
over the country.

Since everyone's curious about QE3, and since last Friday's jobs
report was poor, these speeches will be closely watched for any
hints on the next stages of monetary policy.

But anyway,
his speech has very little about the economy or the next step
in policy. Instead It's all about financial regulation mostly,
though he does say the economy is "far from recovering"
from the financial crisis.

So stay tuned. There are several more speeches coming yet this
week.

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Fostering Financial Stability

I commend the organizers of this conference for the event's apt
subtitle: "The Devil's in the Details." For the Federal Reserve
and other financial regulators, getting the details right is
crucial as we implement the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act) and strive to meet our
broader financial stability responsibilities. About three and a
half years have passed since the darkest days of the financial
crisis, but our economy is still far from having fully recovered
from its effects. The heavy human and economic costs of the
crisis underscore the importance of taking all necessary steps to
avoid a repeat of the events of the past few years.

Tonight I will discuss some ways in which the Federal Reserve,
since the crisis, has reoriented itself from being (in its
financial regulatory capacity) primarily a supervisor of a
specific set of financial institutions toward being an agency
with a broader focus on systemic stability as well. I will
highlight some of the ways we and other agencies are working to
increase the resiliency of systemically important financial firms
and identify and mitigate systemic risks, including those
associated with the so-called shadow banking system. I will also
discuss the broad outlines of our evolving approach to monitoring
financial stability. Our efforts are a work in progress, and we
are learning as we go. But I hope to convey a sense of the strong
commitment of the Federal Reserve to fostering a more stable and
resilient financial system.

Systemically Important Financial
FirmsBanking Institutions

Since the crisis, the Federal Reserve has made important strides
in the traditional, microprudential regulation and supervision of
individual banking organizations. Promoting the safety and
soundness of individual financial firms is a critical
responsibility. To an increasing extent, however, we have also
been working to embed our supervisory practices within a broader
macroprudential framework that focuses not only on the conditions
of individual firms but also on the health of the financial
system as a whole.

Even before the enactment of the Dodd-Frank Act, we had begun to
overhaul our approach to supervision to better achieve both
microprudential and macroprudential goals. In 2009, we created
the Large Institution Supervision Coordinating Committee--a
high-level, multidisciplinary working group, drawing on skills
and experience from throughout the Federal Reserve System--and
charged it with overseeing the supervision of the most
systemically important financial firms. Through the coordinating
committee, we have supplemented the traditional, firm-by-firm
approach to supervision with a routine use of horizontal, or
cross-firm, reviews to monitor industry practices, common trading
and funding strategies, balance sheet developments,
interconnectedness, and other factors with implications for
systemic risk. Drawing on the work of economists and financial
market experts, the coordinating committee has also made
increasing use of improved quantitative methods for evaluating
the conditions of supervised firms as well as the risks they may
pose to the broader financial system.

An important example of our strengthened, cross-firm supervisory
approach is the recently completed second annual Comprehensive
Capital Analysis and Review (CCAR).1 In
the CCAR, the Federal Reserve assessed the internal capital
planning processes of the 19 largest bank holding companies and
evaluated their capital adequacy under a very severe hypothetical
stress scenario that included a peak unemployment rate of 13
percent, a 50 percent drop in equity prices, and a further 21
percent decline in housing prices. From a traditional
safety-and-soundness perspective, we looked at whether each firm
would have sufficient capital to remain financially stable,
taking into account its capital distribution proposal, under the
stress scenario. The simultaneous review, by common methods, of
the nation's largest banking firms also helped us better evaluate
the resilience of the system as a whole, including the capacity
of the banking system to continue to make credit available to
households and businesses if the economy were to perform very
poorly. Because stress tests will be an enduring part of the
supervisory toolkit, we are evaluating the recent exercise
particularly closely to identify both the elements that worked
well and the areas in which execution and communication can be
improved.

We also now routinely use macroprudential methods in analyzing
the potential consequences of significant economic events for the
individual firms we supervise and for the financial system as a
whole. A good example is our response to the European sovereign
debt concerns that emerged in the spring of 2010. Since those
concerns arose, we have been actively monitoring U.S. banks'
direct and indirect exposures to Europe and tracking the banks'
management of their exposures. We have also been analyzing
scenarios under which European sovereign debt developments might
lead to broader dislocations, for example, through a sharp
increase in investor risk aversion that adversely affects asset
values. This work not only has improved our understanding of
banks' individual risk profiles, it also has helped us better
evaluate the potential effects of financial disruptions in Europe
on credit flows and economic activity in the United States.

Macroprudential considerations are being incorporated into the
development of new regulations as well as into supervision. For
example, in December, the Federal Reserve issued a package of
proposed rules to implement sections 165 and 166 of the
Dodd-Frank Act. The rules would establish prudential standards
for the largest bank holding companies and systemically important
nonbank financial firms, standards that become more stringent as
the systemic footprint of the firm increases. We are also
collaborating with the Federal Deposit Insurance Corporation
(FDIC) and foreign authorities to help implement the FDIC's new
resolution authority for systemically critical firms. In
particular, last fall we issued a joint rule with the FDIC that
requires each of these firms to produce a credible plan--known as
a living will--for an orderly resolution in the event of its
failure.

In the international arena, we strongly supported the Basel
Committee's adoption in the summer of 2009 of tougher regulatory
capital standards for trading activities and securitization
exposures. We have also worked closely with international
partners to help develop the Basel III framework, which requires
globally active banks to hold more and higher-quality capital and
larger liquidity buffers, and which now incorporates a provision
to impose capital surcharges based on firms' global systemic
importance. These surcharges are intended to reduce the risk of
failure of systemic firms and also to force these firms, in their
decisions regarding their size and complexity, to internalize the
possible costs that those decisions might impose on the broader
economic and financial system. The purpose of each of these steps
is to improve the traditional prudential regulation of
systemically important firms while fostering greater stability
and resilience in the banking system as a whole.

Nonbank Financial Firms

Gaps in the regulatory structure, which allowed some systemically
important nonbank financial firms to avoid strong, comprehensive
oversight, were a significant contributor to the crisis. The
Federal Reserve has been working with the other member agencies
of the Financial Stability Oversight Council (FSOC), established
by the Dodd-Frank Act, to close these regulatory gaps. On April 3
the FSOC issued a final rule and interpretive guidance
implementing the criteria and process it will use to designate
nonbank financial firms as systemically important.2 Once
designated, these firms would be subject to consolidated
supervision by the Federal Reserve and would be required to
satisfy enhanced prudential standards established by the Federal
Reserve under title I of Dodd-Frank. The FSOC's rule provides
detail on the framework the FSOC intends to use to assess the
potential for a particular firm to threaten U.S. financial
stability. The analysis would take into account the firm's size,
interconnectedness, leverage, provision of critical products or
services, and reliance on short-term funding, as well as its
existing regulatory arrangements.

The FSOC's issuance of this rule is an important step forward in
ensuring that systemically critical nonbank financial firms will
be subject to strong consolidated supervision and regulation.
More work remains to be done, however. In particular, although
the basic process for designation has now been laid out, further
refinement of the criteria for designation will be needed; and,
for those firms that are ultimately designated, it will fall to
the Federal Reserve to develop supervisory frameworks appropriate
to each firm's business model and risk profile. As the FSOC gains
experience with this process, it will make adjustments to its
rule and its procedures as appropriate.

Regulation of Shadow Banking
I have been discussing the oversight of systemically important
financial institutions in a macroprudential context. However, an
important lesson learned from the financial crisis is that the
growth of what has been termed "shadow banking" creates
additional potential channels for the propagation of shocks
through the financial system and the economy. Shadow banking
refers to the intermediation of credit through a collection of
institutions, instruments, and markets that lie at least partly
outside of the traditional banking system.

As an illustration of shadow banking at work, consider how an
automobile loan can be made and funded outside of the banking
system. The loan could be originated by a finance company that
pools it with other loans in a securitization vehicle. An
investment bank might sell tranches of the securitization to
investors. The lower-risk tranches could be purchased by an
asset-backed commercial paper (ABCP) conduit that, in turn, funds
itself by issuing commercial paper that is purchased by money
market funds. Alternatively, the lower-risk tranches of loan
securitizations might be purchased by securities dealers that
fund the positions through collateralized borrowing using
repurchase (repo) agreements, with money market funds and
institutional investors serving as lenders.

Although the shadow banking system taken as a whole performs
traditional banking functions, including credit intermediation
and maturity transformation, unlike banks, it cannot rely on the
protections afforded by deposit insurance and access to the
Federal Reserve's discount window to help ensure its stability.
Shadow banking depends instead upon an alternative set of
contractual and regulatory protections--for example, the posting
of collateral in short-term borrowing transactions. It also
relies on certain regulatory restrictions on key entities, such
as the significant portfolio restrictions on money market funds
required by rule 2a-7 of the Securities and Exchange Commission
(SEC), which are designed to ensure adequate
liquidity and avoid credit losses. During the financial crisis,
however, these types of measures failed to stave off a classic
and self-reinforcing panic that took hold in parts of the shadow
banking system and ultimately spread across the financial system
more broadly.

An important feature of shadow banking is the historical and
continuing involvement of commercial and clearing banks--that is,
more "traditional" banking institutions. For example, commercial
banks sponsored securitizations and ABCP conduits, arrangements
which, until recently, permitted those banks to increase their
leverage by keeping the underlying assets off their balance
sheets. Clearing banks stand in the middle of triparty repo
agreements, managing the exchange of cash and securities while
providing protection and liquidity to both transacting parties.
Moreover, to ease operational frictions, clearing banks extend
very large amounts of temporary intraday credit to borrowers and
lenders each day. This temporary intraday credit--averaging about
$1.4 trillion--allows securities dealers access to their
securities (for example, the tranches of loan securitizations
mentioned earlier) during trading hours.

Because of these and other connections, panics and other stresses
in shadow banking can spill over into traditional banking.
Indeed, the markets and institutions I
mentioned--the repo market, the ABCP market, and money market
funds--all suffered panics to some degree during the financial
crisis. As a result, many traditional financial institutions lost
important funding channels for their assets; in addition, for
reputational and contractual reasons, many banks supported their
affiliated funds and conduits, compounding their own mounting
liquidity pressures.

Status of Shadow Banking Reform Efforts

Given the substantial stakes, I am encouraged that both
regulators and the private sector have begun to take actions to
prevent future panics and other disruptions in shadow banking.
However, in many key areas these efforts are still at early
stages.

A first set of reforms relate to the accounting and regulatory
capital treatment of shadow banking entities sponsored by
traditional banks. The Financial Accounting Standards Board
finalized a rule in 2009 that requires securitizations and other
structured finance vehicles, in certain situations, to be
consolidated onto the sponsoring bank's balance sheet. In the
context of regulatory capital, Basel 2.5 and Basel III addressed
interconnectedness and other sources of systemic risk frequently
associated with shadow banking by raising capital requirements
for exposures to unregulated financial institutions, such as
asset managers, hedge funds, and credit insurers, and by
strengthening the capital treatment of liquidity lines to
off-balance-sheet structures. Basel III also includes
quantitative liquidity rules that reflect contractual and other
risks that arise from bank sponsorship of off-balance-sheet
vehicles.

A second area of ongoing reform is money market funds. In an
important step toward greater stability, the SEC in 2010 amended
its regulations to, among other things, require that money market
funds maintain larger buffers of liquid assets, which may help
reassure investors and reduce the likelihood of runs.
Notwithstanding the new regulations, the risk of runs created by
a combination of fixed net asset values, extremely risk-averse
investors, and the absence of explicit loss absorption capacity
remains a concern, particularly since some of the tools that
policymakers employed to stem the runs during the crisis are no
longer available. SEC Chairman Mary Schapiro has advocated additional measures
to reduce the vulnerability of money market funds to runs,
including possibly requiring funds to maintain loss-absorbing
capital buffers or to redeem shares at the market value of the
underlying assets rather than a fixed price of $1. Alternative
approaches to ensuring the stability of these funds have been
proposed as well. Additional steps to increase the resiliency of
money market funds are important for the overall stability of our
financial system and warrant serious consideration.

A third set of emerging reforms is aimed at repo markets, an area
in which the Federal Reserve has taken an active role. The
initial efforts have focused on the vulnerabilities created by
the large amounts of intraday credit provided by clearing banks
in the triparty repo market. Intraday credit, while a great
convenience in normal times, may foster systemic risk by creating
large mutual exposures between securities dealers and clearing
banks. In times of market stress, a dealer default on intraday
credit extended could be large enough to pose a threat to the
stability of the clearing bank--institutions tightly connected to
the rest of the financial system. But were a clearing bank to
decline to provide intraday credit to a dealer, that dealer's
ability to operate normally would be substantially compromised,
likely causing difficulties for its clients and counterparties,
including many other financial institutions. As a result, during
a period of market stress, the actions of clearing banks can
jeopardize the stability of securities dealers, and vice versa.

An industry task force recognized this mutual vulnerability in
2010 and recommended the "practical elimination" of intraday
credit in the triparty repo market. Although some progress has
been made, securities dealers and clearing banks have yet to
fully implement that recommendation. Nevertheless, through
supervision and other means, we continue to push the industry
toward this critical goal. In doing so, we are collaborating with
other agencies, notably the SEC, which has regulatory
responsibility for money market funds and securities dealers,
institutions that are active in the triparty repo market. At the
same time, we continue to urge market participants to improve
their risk-management practices, and, in particular, to ensure
that tools are in place to address the risks that would be posed
to the repo market by the default of a major firm.

International regulatory groups have also been focused on
addressing the financial stability risks of shadow banking. The
Group of Twenty leaders have directed the Financial Stability
Board (FSB), whose membership consists of key regulators from
around the world, including the Federal Reserve, with developing
policy recommendations to strengthen the regulation of the shadow
banking system. The FSB currently has five major projects under
way devoted to understanding the risks of, and developing policy
recommendations for, shadow banking. The areas under study
include money market funds, securitization, securities lending
and the repo market, banks' interactions with shadow banks, and
"other" shadow banking entities. Given the substantial variation
in the structure of shadow banking in different countries, the
FSB's agenda is ambitious. But it is also critical in light of
the potential risks to stability from shadow banking and the ease
with which shadow banking entities can create intermediation
chains across national borders.

Monitoring Financial Stability
I've outlined a number of ongoing efforts, both domestic and
international, to bring the shadow banking system into the
sunlight, so to speak, and to impose tougher standards on
systemically important financial firms. But even as we make
progress on known vulnerabilities, we must be mindful that our
financial system is constantly evolving, and that unanticipated
risks to stability will develop over time. Indeed, an inevitable
side effect of new regulations is that the system will adapt in
ways that push risk-taking from more-regulated to less-regulated
areas, increasing the need for careful monitoring and supervision
of the system as a whole.

At the Federal Reserve, we have stepped up our monitoring efforts
substantially in recent years, with much of the work taking place
under the auspices of our recently created Office of Financial
Stability Policy and Research. We conduct an active program of
research and data collection, often in conjunction with other
U.S. and foreign regulators and supervisors, including our fellow
members on the FSOC. In addition, by making use of resources
throughout the Federal Reserve System, we are developing a
framework and infrastructure for monitoring systemic risk. Our
goal is to have the capacity to follow developments in all
segments of the financial system, including parts of the
financial sector for which data are scarce or that have developed
more recently and are thus less well understood. This work
complements and is closely coordinated with our efforts,
mentioned earlier, to supervise systemically important banking
organizations from a macroprudential perspective. For example,
based on public data, we develop and monitor measures of systemic
importance that reflect firms' interconnectedness and their
provision of critical services.

Unfortunately, data on the shadow banking sector, by its nature,
can be more difficult to obtain. Thus, we have to be more
creative to monitor risk in this important area. We look at broad
indicators of risk to the financial system, such as measures of
risk premiums, asset valuations, and market functioning. We try
to gauge the risk of runs by looking at indicators of leverage
(both on and off balance sheet) and tracking short-term wholesale
funding markets, especially for evidence of maturity mismatches
between assets and liabilities. We are also developing new
sources of information to improve the monitoring of leverage. For
example, in 2010, we began a quarterly survey on dealer financing
(the Senior Credit Officer Opinion Survey on Dealer Financing
Terms) that collects information on the leverage that dealers
provide to financial market participants in the repo and
over-the-counter derivatives markets.3 In
addition, we are working with other agencies to create a
comprehensive set of regulatory data on hedge funds and private
equity firms.

Broader economic developments can also create risks to financial
stability. To assess such risks, we regularly monitor a number of
metrics, including, for example, the leverage of the nonfinancial
sector. In addition, we use data from the flow of funds accounts
to assess how much nonfinancial credit is ultimately being funded
with short-term debt.4 This
assessment is important because an overleveraged nonfinancial
sector could serve to amplify shocks, to the detriment of the
functioning of the financial sector and broader economy. Our
judgment of how the financial sector is affecting economic
activity reflects both information on lenders--most notably,
underwriting standards, risk appetite, and balance sheet
capacity--and analytical indicators of macroeconomic
vulnerability to financial risks. Meanwhile, efforts are under
way, both at the Federal Reserve and elsewhere, to evaluate and
develop new macroprudential tools and to develop early warning
indicators that could help identify and limit future buildups of
systemic risk.

In the decades prior to the financial crisis, financial stability
policy tended to be overshadowed by monetary policy, which had
come to be viewed as the principal function of central banks. In
the aftermath of the crisis, however, financial stability policy
has taken on greater prominence and is now generally considered
to stand on an equal footing with monetary policy as a critical
responsibility of central banks. We have spent decades building
and refining the infrastructure for conducting monetary policy.
And although we have done much in a short time to improve our
understanding of systemic risk and to incorporate a
macroprudential perspective into supervision, our framework for
conducting financial stability policy is not yet at the same
level. Continuing to develop an effective set of macroprudential
policy indicators and tools, while pursuing essential reforms to
the financial system, is critical to preserving financial
stability and supporting the U.S. economy.

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ORIGINAL POST: Is Bernanke leaning towards more
monetary easing?

That's arguably the biggest question the market is asking right
now, as investors fret that the
end of cheap money means the market is doomed to swoon like
it did last summer.

Soon, Ben Bernanke is going to be speaking at an
Atlanta Fed conference, and we might get some hints on where his
head is.

Stay tuned. We'll have the speech right here as soon as it's out.
He's schedule to speak at 7:15 PM ET.